The Rise of Perpetual Futures: How Derivatives Markets Shape Crypto Prices

The process of setting crypto prices is often misunderstood, with many believing it is driven by spot trading. However, perpetual futures, also known as perps, have become the dominant force in the market, accounting for around 93% of all crypto futures volume. These contracts, which never expire, allow traders to buy and sell with leverage, and their prices are determined by the funding rate, which is paid by the crowded side of the trade every few hours. Research has shown that perps are the primary source of price formation in the crypto market, with spot exchanges reacting to, rather than leading, price movements. A study by Carol Alexander and co-authors found that perpetual swaps on unregulated venues were the strongest instruments for bitcoin price discovery, while other work has identified Binance's perpetual market as the primary source of price formation. The use of perps in pricing the SpaceX IPO is a prime example of their influence, with traders on Binance, Coinbase, and other exchanges buying and selling exposure to the company through pre-IPO perpetual futures. The accuracy of these contracts in predicting the IPO price highlights the growing importance of derivatives markets in shaping prices. However, the limitations of perps in pricing supply were also evident, as the subsequent decline in SpaceX's stock price was driven by the release of locked-up insider shares, a factor that perps could not have accounted for.